Precious metals prices are soaring in the wake of last week’s disastrous payroll number.  The latest nonfarm payroll print at 142,000 with the prior revision from 173,000 to 136,000 underlining the softness in job creation metrics.  While most market analysts are looking for numbers in the 200,000 range to signal sustainable job creation and potential liftoff, the latest data confirms that the Federal Reserve is increasingly likely to miss the window for exiting zero interest rates.  Dollar momentum has been dented by the latest data, helping to foment a further rally in silver prices after the precious metal broke through a key technical level on the upside.  However, while the Federal Reserve might have shifted back its timetable, a dollar funding crisis might pave the way for further losses in precious metals once the music stops.

The Fundamental Picture

Similar to other precious metals prices, silver prices are commonly used as a hedge against inflation and money printing by Central Banks.  At this point, considering the pool of global liquidity unleashed by global institutions, it is surprising that silver prices have not risen further as the outlook for monetary policy sours.  However, in truth, there are two major fundamental factors pressuring prices lower over the medium-term including the end of asset purchases and widespread deflation.  Although policymakers will typically caution against using the word as it summarizes a failure of quantitative easing, deflation is about to become more widespread as evidenced by the latest trends in advanced economies such as the United Kingdom, Euro Area, Germany, and Spain.  The United States is unlikely to be far behind when it comes to the deflationary trend.

While in the paper market silver prices have the potential to fall sharply based on outstanding fundamental indicators, namely inflation especially for dollar-denominated prices, the physical market for silver is much tighter.  Recent trends show that demand for bullion continues to edge higher, with the US Mint recording the highest sales since 1986 in the third quarter.  Accordingly, some global mints have been setting quotas for sales as a result of soaring demand that is creating stress on the existing supply chain and manufacturing capabilities.  Many investors are eyeing the sharp spread between gold and silvers prices as a buying opportunity to take physical at a substantial discount to gold. However, much of the momentum is being driven at the moment by retail investors in what can be a worrying sign for the recent price rally.  Typically, retail investors are noted for being behind the curve and signal counter-momentum in the opposite direction.

The Technical Take

When combining with the fundamental outlook for precious metals prices and the key characteristics of the physical bullion market, it is not hard to see that catalysts for higher prices in the short-to-medium term exist for silver.  The price action of both the Friday and Monday sessions are very reminiscent of a short squeeze.  Based on the most recent CFTC data made available last Friday, net long futures positions in silver actually shrunk by a small amount, contracting from 24,900 to 23,100.  However, with the futures markets seeing shrinking long interest, it created the perfect scenario for silver prices to break higher on the poor US fundamentals.  Friday saw prices break above the 50-day moving average which might be at a turning point.  Although still trending below the longer-term 200-day moving average, prices did manage to close above key resistance at 15.560, a strong sign that prices could run even further to the upside.

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The rebound in silver prices from multi-year lows at 13.989 on August 26th from levels last seen in 2009 marks a sharp departure from the longer-term downward bias.  Although not necessarily a turning point in prices and signaling a longer-term reversal, the recent uptick does look like a squeeze play.  On a longer-term basis, the descending triangle technical pattern is still in play, with silver trading below the downtrend line, consolidating between the trendline and support at the 14.000 handle.  Although short-term, Call positions initiated above the key 15.560 level should target 16.160 on the upside which remains the next major resistance level.  However, expect further resistance at the downtrend line, which could pressure prices lower.  On a longer-term basis, relief rallies and short squeezes akin to current price action should be taken as opportunities to take Put positions targeting 14.000 and the most recent lows at 13.989.  If broken, the next target for Put positions is 12.650 on the downside.

Conclusion

Although recent fundamentals might have indicated a near-term technical rebound to the upside in silver prices, on a longer-term basis, prices have not yet confirmed a reversal, meaning recent price action has not undone the longer-term thesis and bearish bias. Should the prevailing downtrend line be broken to the upside, it could signal a deeper correction and pullback higher.  However, even though the physical market remains undersupplied and retail buying momentum remains higher, longer-term factors such as deflation and a stronger dollar might potentially undo recent gains.  While short-term traders might benefit from Call positions taking advantage of the rallies and bounce in prices, investors with a longer time horizon would be well-suited to evaluate rallies as an opportunity to take Put positions to capitalize on the prevailing trend lower.